Thus a direct relationship between duration and price

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Unformatted text preview: , duration ↑. Thus a direct relationship between duration and price sensitivity is expected. D. Since cash flows in the form of coupon interests are received prior to maturity, the investor does not need to wait until maturity to recover the cost of investment. Hence the duration of a coupon bond is generally smaller than its time to maturity. E. The duration is 0.5 years since the remaining cash flows (FV and final coupon interest) are all received six months later when the bond matures and the present value of the cash flows is equal to the cost of investment. Thus the duration of a coupon bond is not always smaller than its time to maturity. It can be the same as or less than the time to maturity. F. Yes, this investment is risk-free since you are certain of the cost and terminal value of the investment. G. Assumption 1: The yield curve is flat at the time of bond investment. This ensures that the expected return from the bond is the same return as its initial yield to maturity. Assumption 2: Any unexpected change in rates applies to the entire spectrum of maturities, i.e., the yield curve experiences a parallel upward/downward shift. This ensures that the unexpected rise (fall) in coupon reinvestment income offsets the unexpected fall (rise) in the selling price of the bond completely. Assumption 3: Prior to any unexpected change in rates, the bond’s duration matches the intended holding period. Otherwise, price risks will not offset income risks completely. 2...
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This note was uploaded on 10/29/2010 for the course FINS 2624 taught by Professor Hneryyip during the Three '10 term at University of New South Wales.

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